Friday, January 04, 2008

I’m Sticking with 2.0

Despite Friday’s soft jobs number, I do not believe we are heading into a recession. Any slowdown in the U.S will be very short-lived. I’m sticking with Goldilocks 2.0.

Payroll jobs rose a mere 18,000 for December. But we had a 115,000 jobs gain in November and a 159,000 gain in October. And with Friday’s ISM non-manufacturing business barometer coming in strong, December payrolls might be revised upward. Still, it’s just one soft month. On a year-on-year basis, non-farm payrolls increased 1.3 million, or roughly 1 percent. Aggregate hours worked increased 1 percent annually in the fourth quarter, producing at least 2 percent real growth for the quarter.

Yes, the Goldilocks economy is a bit softer than I’d like. But that’s why the Fed needs to deliver a 50 basis point rate cut at its January 30 meeting. Back in 2000-01, when the economy was slowing markedly, the Fed obsessed about inflation. It’s the same story again. The money supply hasn’t grown in a few years while inflation over the next couple years is poised to go way down. Meanwhile, the yield curve is still inverted in the Treasury markets, a key signal that rates are too high.

A 50 basis point cut would help businesses, consumers, and mortgage owners. It would make the cost of money cheaper and expand the overall liquidity base of the economy. The reality is that the economic weakness is coming from the business side. Domestic business profits are falling at about a 6 percent clip. They’re due to fall some more in the fourth-quarter data. We’re witnessing high energy and raw-material prices cause unit costs for businesses to rise faster than prices. Business inflation is only 1.5 percent. So this is a business slowdown.

The key thing to remember is that businesses drive the economy. Businesses create jobs and incomes for consumers to spend. Today’s John Edwards/Mike Huckabee anti-business populism sounds more like William Jennings Bryan than Adam Smith. It’s absolutely crazy. They attack Wall Street and investors, which is another way of attacking capital. Without capital investment, there will be no new business, no new jobs, and no middle class.

Some folks argue that rising inflationary pressures would offset these benefits. But that’s nonsense. I disagree with the link between Fed rate cuts and inflation. Inflation is the most overrated issue out there right now. Even when you factor in energy, headline inflation in 2007 is going to come in below the prior year while 2008 inflation should be even lower than that.

As for this notion that consumers are tapped out, take a look at disposable income. After inflation, it is rising better than 2 percent. Strong income gains of 3.7 percent for hourly earnings are running 1 percentage point ahead of the headline PCE (personal consumption expenditures) measure. As it happens, car sales numbers were strong this week. They’re running 3.6 percent at an annual rate, ahead of the third quarter. Meanwhile, the holiday sales season has surprised on the upside.

So let’s not get our feathers all aflutter over one month’s jobs number. Look at the broad picture. Over the long run, American-style free-market capitalism remains the single best path to prosperity. And while today’s Goldilocks economy may be a little softer than desired, she remains alive and well. A little help is all she needs.

Right now the single best thing President Bush and Congress can do is slash the corporate tax rate for large and small businesses. Bush can reach out to Charlie Rangel and move the corporate tax to 25 percent from 35 percent. Then, instead of taxing successful capitalists as an offset, corporate-tax subsidy loopholes, special provisions, and other corruption-inducing K-Street tax earmarks can be eliminated.

A middle-class tax cut to help families and small businesses would also be welcome. This can be done by collapsing the three middle-income tax brackets of 15 percent ($15,650), 25 percent ($63,700), and 28 percent ($128,500) into one 15 percent bracket. These brackets apply to small-business owners who may be suffering the high costs of energy and raw materials. The biggest weakness in the jobs report is the household survey which is comprised of these owner-operated small businesses. Household job increases have slumped to only 262,000 over the last year, compared to a 1.3 million increase for larger corporations.

Essentially, a major cut in the corporate tax and a simplification of the middle-income tax brackets makes good sense for long-run tax reform. It would help the current softening of the economy and increase America’s long-run potential to grow. This is a good plan for President Bush as well as the GOP candidates on the campaign trail.

Just because Goldilocks is alive and well, it doesn’t mean she can’t use a bit of help.

About Me

Larry Kudlow

Lawrence Kudlow is CNBC’s Senior Contributor. For many years, he was the host of CNBC’s “The Kudlow Report”. He is also the host of The Larry Kudlow Show, which broadcasts on Saturdays from 10am to 1pm ET on WABC Radio and is syndicated nationally by Cumulus Media. He is also a nationally syndicated columnist and a former Reagan economic advisor. CNBC's The Kudlow Report also airs on Sirius (ch.129) and XM (ch.127) weeknights at 7pm ET.